Angela Colley — Building Blocks
There are a lot of good reasons to buy a house. For one, the rent is still too damn high. While rent rates have been slowly declining on a national level lately, if you’re living in a major city, finding a place that won’t suck up more than a third of your take-home pay is still hard. In New York City, the median rent for a one bedroom apartment is $2,080. Los Angeles comes in at $1,340, and Chicago hits $1,060, according to data from Apartment List. And that’s the median rate. In practice, finding a decent spot for the median rent is near impossible unless you’re willing to live far from the city center and put in several weeks of scouring local listings.
Then there’s the whole equity thing. When you’re paying rent, you’re helping your landlord build their own (mostly) passive income stream, but when you’re paying a mortgage, you’re building value in your home and boosting your net worth.
When it comes to getting a mortgage, qualifying takes some effort—and likely reams of paperwork. But don’t let that scare you. Many people feel that the effort is more than made up for by the security of owning their home.
Step 1: Buy or rent?
You may have many non-financial reasons to buy a home—like the freedom to remodel, or rid yourself of annoying downstairs neighbors, or finally install those lawn gnomes—but when you’re considering purchasing a house you should start by crunching the numbers. Renting is almost always cheaper upfront than buying (especially comparing that hefty down payment to the cost of a security deposit and first and last month’s rent), but over time paying rent every month could end up costing more than buying a home. To see if that’s the case in your area, and when you’d break even (or even save money) by buying a home, start with a Rent vs. Buy calculator.
Step 2: Get your credit in shape
You don’t need absolutely perfect credit to qualify for a mortgage. Still, the higher your score, the better your interest rates and terms will be. Those with less-than-stellar scores may have some luck getting approved through specific programs like those offered by the Federal Housing Administration and Department of Veterans Affairs.
Ideally six months or more before you apply for a mortgage, pull your credit reports and scores from all three credit bureaus. (You’re entitled by law to free credit reports from each bureau annually through AnnualCreditReport.com, but you’ll need to buy your scores through the credit bureaus.)
Once you have your scores, dispute any mistakes you find by mailing a letter to the credit bureau directly or filing one on their website. From there, follow the three golden rules to raise and keep a high credit score:
Pay your bills on time: Paying your bills on time, every time has the biggest impact on your credit score.
Keep your balances low: Keeping your balances under 30 percent of your available credit limit helps keep your credit scores high.
Don’t take on more than you need: Resist the urge to apply for more credit than you need. Credit applications and new debts can lower your credit scores. When you know you’re going to buy a house, skip the credit apps for at least six months.
Step 3: Build up your cash stash
You know you’ll need a down payment to buy a home, but it isn’t as simple as that. In order to get approved for a mortgage, you’ll need additional cash reserves, which can range from as little as 5 percent to 20 percent or more depending on which loan type you choose. Here’s what you should have on hand before you start shopping for a home:
Step 4: Find a loan
Once your credit is in good shape and you have the upfront money on hand, it’s time to start shopping for a loan. You can go through a mortgage broker, who essentially does the legwork for you by finding a loan and guiding you through the application process, but it will cost you a fee—typically a small percentage of your total loan. Or you can opt to go it alone.
If you’re planning to fly solo, there are two types of loans to consider. The most common, conventional loans, are backed by a lender. You’ll be able to buy any house you want—including a fixer-upper Victorian or converted gas station, the sky’s the limit—but there are a couple of hurdles. If you don’t have 20 percent to put down, you’ll pay private mortgage insurance every month until you have enough equity to guarantee the loan. And you may need a good or excellent credit score to qualify.
Government-backed loans are done through a lender but secured by either the FHA, VA, or United States Department of Agriculture. On the plus side, government-backed loans don’t require as much down (you may get in for 5 percent or less) and lower credit scores aren’t a deal breaker, but there’s a catch. To get approved, you’ll have to meet other requirements. VA loans only go to military members. FHA loans require the house you’re buying meet specific standards, and USDA loans are only for rural areas.
No matter what loan type you choose, apply with several lenders. In a 30-day period, multiple applications only count against your credit score once, and it is the best way to ensure you’re getting the best deal possible.
Happy (house) hunting!